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Make no little plans. They have no magic to stir men’s blood…Daniel Burnham

A lot of entrepreneurs think that their startup is the next big thing when in reality they’re just building a small business. How can you tell if your startup has the potential to be the next Google, Intel or Facebook? A first order filter is whether the founders are aiming for a scalable startup.

Go For BrokeA few years ago I sat on the board of IMVU when the young company faced a choice my mother used to describe as “you should be so lucky to have this problem.” For its first year IMVU had funded itself with money from friends and family. Now with customers and early revenue, it was out raising its first round of venture money. (Not only did their sales curve look like a textbook case of a VC-friendly hockey stick, but their Lessons Learnedfunding presentation was an eye-opener.)

Staring at us in the board meeting were three term-sheets from brand name VC’s and an unexpected buy-out offer from Google. In fact, Google’s offer for $15 Million was equal to the highest valuation from the venture firms. The question was: what did the founders want to do?

Will Harvey, Eric Ries and the other founders were unequivocal – “Screw the buy-out, we’re here to build a company. Lets take venture capital and grow this thing into a real business.”

The Scalable StartupWill and Eric implicitly had already made six decisions that defined a scalable startup.

Their vision for IMVU was broad and deep and very big – 3D avatars and virtual goods would eventually be everywhere in the on-line world. They wanted to build an industry not just a product or a company.

Their personal goal wasn’t to have a company that stayed small and paid them well. Nor did they think flipping the company to make a few million dollars would be a win. They believed their vision and work was going to be worth a lot more – or zero.

They envisioned that their tiny startup was to going to be a $100 million/year company by creating an entirely new market – selling virtual goods.

They used Customer and Agile development to search for a scalable and repeatable business model to become a large company. It reduced risk while allowing them to aim high.

They fervently believed that only they were the ones who could and would make this happen.

These decisions guaranteed that the outcome of the board meeting was preordained. Selling out to Google would mean that someone else would define their vision. They were too driven and focused to let that happen. A few million dollars wasn’t their goal. Taking venture money was just a means to an end. Their goal was to get profitable and big. And risk capital allowed them to do that sooner than later. Venture money also meant that the VC’s goals of obscene returns were aligned with the founders. For the entire team, turning down the Google deal was equivalent to burning the boats on the shore. (One founder quit and joined Google.) After that, there was no doubt to existing employees and new hires what the company was aiming for.

Take No PrisonersA “scalable startup” takes an innovative idea and searches for a scalable and repeatable business model that will turn it into a high growth, profitable company. Not just big but huge. It does that by entering a large market and taking share away from incumbents or by creating a new market and growing it rapidly.

A scalable startup typically requires external “risk” capital to create market demand and scale. And the founders must have a reality distortion field to convince investors their vision is not a hallucination and to hire employees and acquire early customers. A scalable startup requires incredibly talented people taking unreasonable risks with an unreasonable effort from the founders and employees.

Not All Startups are ScalableThe word entrepreneur covers a lot of ground. Itmeans someone who organizes, manages, and assumes the risks of a business. Entrepreneurship often describes a small business whose owner starts up a company i.e. a plumbing supply store, a restaurant, a consulting firm. In the U.S. 5.7 million companies with fewer than 100 employees make up 99.5% of all businesses. These small businessesare the backbone of American capitalism. But small businesses startups have very different objectives than scalable startups.

First, their goal is not scale on an industry level. They may want to grower larger, but they aren’t focused on replacing an incumbent in an existing market or creating a new market. Typically the size of their opportunity and company doesn’t lend itself to attracting venture capital. They grow their business via profits or traditional bank financing. Their primary goal is a predictable revenue stream for the owner, with reasonable risk and reasonable effort and without the need to bring in world-class engineers and managers.

The Web and StartupsThe Internet has created a series of new and innovative business models. Herein lies the confusion; not every business on the web can scale big. While the Internet has enabled scalable Internet startups like Google and Facebook, it has also created a much, much larger class of web-based small businesses that can’t or won’t scale to a large company. Some are in small markets, some are run by founders who don’t want to scale or can’t raise the capital, or acquire the team. (The good news is that there is an emerging class of investors who are more than happy to fund and flip Web small businesses.)

Scalable Startup or Small Business – Which One is Right?There’s nothing wrong with starting a small business. In fact, it is scalable startups that are the abnormal condition. You have to be crazy to make the bet the IMVU founders did. Unfortunately the popular culture and press have made scalable startups like Google and Facebook the models that every entrepreneur should aspire to and disparages technology small businesses with pejoratives like “lifestyle business.”

That’s just plain wrong. It’s simply a choice.

Just make it a conscious choice.

Lessons Learned

Not all startups are scalable startups

6 initial conditions differentiate a scalable startup from a small business;

Steve. Long time no talk (think ardent, wegbreit days). The world-class team lesson rings true to me after 30 years recruiting those guys/gals to startups. I am about to turn down a chance to do a CFO search for a founder who has raised $9mm of VC for his 16-person company. He hired his first CFO from Craigslist (who, no surprise, is not a fit), he wants to pay any recruiter 15% of 150K (too low salary to attract a star performer and too low fee to attract a star recruiter), and he “doesn’t have time” to meet me face-to-face. By his own words he is leading a “cult” – reality-distortion indeed, but not building a TEAM.

Paul,
Happy New Year. Well said. I agree completely, and with my 20 years executive search experience appreciate your standards. I will be writing an article soon about such for an industry publication. Keep up the good work.

Steve, love to see your thoughts on the important points for the “small business” type business to succeed. Other than the financing path, it seems that most of the same principles apply, right? (get out of the building, minimum viable product, etc.)

I teach Entrepreneurship and work exclusively with small and mid sized businesses. Your post is very relevant because I try to differentiate Small Business and Entrepreneurship in the areas of Scalability and Replicability. The book, The E-Myth and a Harvard Business Review article on Why Entrepreneurs don’t scale help me frame this discussion.

This is probably the best piece on differentiating Small Business and Entrepreneurship as well as making the case that both are OK.

I will be saving this piece for future Entrepreneurship classes… thanks for the pointed insight….

Steve, nice post. Long time no talk (think e.piphany days). The world-class team lesson rings true to me after 20 years recruiting those folks to startups. Like Paul, I am turning down searches for founders who hire key employees via Linkedin ads and Craigslist, or wanting to pay recruiters 15% of too low salaries to attract a star performer and too low of fee to attract a good recruiter. It is all about building a great team and the results are a great company. Well said.

Steve, your insights belong in an MBA 101 book (if they aren’t already). A friend of mine’s brilliant son graduated from Harvard’s MBA program with stars in his eyes and has cycled through a few startups with such grand scalable visions that ended up hindering their daily business growth and forced him to move on. I recently previewed a new book Built To Sell that reflects what you’re saying about making a conscious choice and suggests having an “options strategy,” not just an exit strategy for the founder or founding team.

This post reminded me of a presentation by Basil Peters to a group of Entrepreneurs talking about planning your exit strategy right at the beginning of your new venture. He talked about how most of the aquisitions are in the $15 to $30 million dollar range these days. Google made a number of its key acquisitions in this price range including Adsense from which google makes a significant portion of its revenue. Have a look at Basil’s video presentation at the following link.

[…] an existing market and taking customers from existing companies or creating a new market. Scalable startups aim to provide an obscene return to their founders and investors using all available outside […]

I do not understand the “world class team” part. Is it a world class *team* or a team of world-class players. If players all must be world class – what does it mean? Were Jobs and Woz a world class team in 1976? Were Brin and Page a world class team in 1994? 1998? 2001? Were Semel and Yang a world calss team? Was the founder who defected to Google a world class after all? If young and promising people do not get a chance, how do we get world class teams? Can you explain this, maybe in a separate post?

This is very similar to the difference between Small Businesses and Startups. The first time I heard it, it was from Steve Blank. He groups “scalable startups” as technology driven companies like web-startups, engineering firms, and others usually co…